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Commentary: Loans For College Don't Have To Crush Grads

July 11, 1999

Economics

Commentary: Loans for College Don't Have to Crush Grads

In today's economy, you can't get anywhere without a college degree. Just look at the numbers. Today's male and female college grads, respectively, earn a wage premium of 44% and 51% over those with only a high school diploma, according to the Economic Policy Institute. No wonder college enrollment is at an all-time high.

But the flip side of the college boom is that a growing number of students are taking on significant debt burdens. In 1997-98, students took out $36 billion in loans, more than double 10 years earlier, even after adjusting for inflation. Loans now make up 60% of financial aid, compared with 52% ten years ago.

The current reliance on oversized loans is placing far too much risk on college students, many of whom now start their working lives deep in debt. That's not a big problem for those graduates who go on to work in Silicon Valley or Wall Street, but the loan payments are a heavy burden for most everyone else. Moreover, the prospect of taking on heavy debt is particularly daunting for students from low-income families, who need the biggest loans and who do not have the safety net of parental resources to help out if things go bad.FORGIVEN. To make the college financing system less risky for students, what's needed is a broad shift to "income contingent" student loans, where payments depend on income. Graduates in higher-salaried jobs would pay off their loans more quickly with bigger payments, while those in lower-salaried jobs would have much smaller payments that would be heavily subsidized by the taxpayer. Eventually, suggests Thomas Kane, a Harvard University economist, a chunk of the loan would be forgiven for those with low lifetime earnings after 25 years, with taxpayers bearing the cost of loan forgiveness. The result: Low- and middle-income college students could be sure that they would not be stuck with loans that they could not pay off.

Right now such repayment schemes are available, but only to the limited number of students who borrow directly from the government. So the idea of income-contingent loans needs to be greatly extended to cover the broad range of public and private student loans. This will require government guarantees to private lenders to cover the forgiveness of student debt after 25 years. Moreover, some government subsidies will be needed to hold down loan payments for the lowest-income borrowers.

Of course, income-contingent loans would make a banker shudder. Other consumer debts, such as car loans and home mortgages, do not alter the payment schedule when the value of the home or the car fluctuates, or when the income of the borrower changes. But education loans are an investment in a long-term productive asset--an educated worker. That makes it considerably more appropriate to link payments to the earnings of the graduate.

A shift to income-contingent loans would take into account the growing reality that not all college graduates have equal earning power. Indeed, the incomes and wages of college-educated Americans have become more dispersed since 1970. Some graduates become social workers, while others become computer programmers or management consultants.SIDESTEP THE PROBLEM. Moreover, income-contingent loans would be a way of lowering the barriers to college for low-income students. That's important, since the gaps in college entry by family income seem to have widened recently, according to Kane. After adjusting for parental education and youth test scores, there remains a 15-percentage-point gap between the college enrollment rate of youth from the top family-income strata and those from the lowest earnings group.

To be sure, a poorly designed system of income-contingent loans can easily fall apart, if high-income borrowers feel taken advantage of. That's what happened when Yale University tried such a system in the 1970s, where high-income students effectively subsidized low-income students and people who defaulted. But a national system that ensured no one would pay more for their education than they would under the current fixed-payment system, while making up the shortfall from general government revenues, should avoid this problem.

More than ever, a college education is a productive investment---both for the individual and the economy. With a system of income-contingent loans, anyone who wants to go to college can--and that can only be good for society.By Christopher Farrell